Morningstar DBRS Upgrades BMPS’s Long-Term Issuer Rating to BB (high) from BB (low), Positive Trend

DBRS Ratings GmbH (Morningstar DBRS) upgraded Banca Monte dei Paschi di Siena SpA's (BMPS or the Bank) Long-Term Issuer Rating to BB (high) from BB (low). At the same time, Morningstar DBRS upgraded the Short-Term Issuer Rating to R-3. Morningstar DBRS also upgraded the Long-Term and Short-Term Critical Obligations Ratings (COR) to BBB/ R-2 (high). The Bank's Deposit ratings were upgraded to BBB (low), one notch above the IA, reflecting the legal framework in place in Italy which has full depositor preference in bank insolvency and resolution proceedings. The Bank's subordinated notes were also upgraded by three notches to BB (low) from B (low) to revert to our standard notching for European subordinated debt. The trend on all long-term credit ratings is Positive. The Intrinsic Assessment (IA) is now BB (high), while the Support Assessment remains SA3. A full list of rating actions is included at the end of this press release.

KEY CREDIT RATING CONSIDERATIONS
The two-notch upgrade of the credit ratings considers the significant improvements BMPS has carried out in the past 12 - 18 months. Morningstar DBRS notes that the Bank's high sensitivity to interest rates, in line with the sector, has led to a substantial increase in revenues on top of improvements related to the evolution of the business mix. On top of this, the successful execution of the voluntary exit scheme of 4,000 employees in December 2022 has brought structural improvements in operating efficiency, countering ongoing inflationary pressures. The upgrade also incorporates the Bank's structurally lower cost of risk. The Positive Trend reflects that Morningstar DBRS expects these elements to continue to support profits in 2024.

The upgrade also reflects that whilst BMPS's reputation has previously suffered from legacy conduct issues, a series of positive judicial outcomes in late 2023 have led to a significant reduction in outstanding legal risks. Finally, in upgrading the credit ratings, Morningstar DBRS incorporates BMPS's strong capital position which is now at the higher-end of its peer group and the renewed distribution policy, two years ahead of the business plan target.

Morningstar DBRS expects that BMPS´s asset quality could deteriorate somewhat in coming quarters given the challenging economic environment, characterised by tighter financial conditions, still high inflation, and weaker economic dynamics. Nevertheless, in upgrading the credit ratings, Morningstar DBRS expects BMPS's improved starting point, tightened underwriting standards, and improved earnings generation capacity will provide the Bank with flexibility to weather the headwinds ahead.

The credit ratings continue to be underpinned by a stabilised funding and liquidity profile and renewed issuances on the wholesale markets in 2023 and early 2024. The credit ratings also continue to take into account the Bank's franchise as one of the largest Italian banks with a good domestic footprint.

CREDIT RATING DRIVERS
An upgrade of the credit ratings would require demonstration of a sustained capacity to generate earnings, further improvement in asset quality metrics and maintaining a sound capital position. An upgrade would also require the Bank to access wholesale markets more regularly and fully resolve outstanding extraordinary legal issues.

A downgrade would occur in the case of a substantial deterioration in asset quality or profitability. Failure to maintain adequate liquidity buffers would also lead to a downgrade.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Moderate
BMPS is Italy's fourth largest bank by total assets and has significant market share in its home region of Tuscany. The Bank was subject to a precautionary recapitalisation by the Italian State in 2017. Following this, BMPS underwent a restructuring plan to improve efficiency with the closure of branches and headcount reduction. In addition, the Bank substantially reduced NPEs which, combined with organic reduction, resulted in a cleaner balance-sheet. The Bank remains partly owned by the Italian Ministry of Finance (MEF), which sold through two accelerated procedures 37.5% of its 64% remaining participation in the Bank. The Bank's franchise has suffered some reputational damage from legacy conduct issues, in particular litigation risk linked to prior capital increases. However, the recapitalisation of EUR 2.5 billion restored capital levels in November 2022, and has provided room to successfully executed some of the main targets of the 2022-2026 restructuring plan, including significant number of early retirements, simplification of the Group's structure and further balance sheet clean-up.

Earnings Combined Building Block (BB) Assessment: Moderate
After several years of weak profitability, BPMS has returned to profitability and has demonstrated its capacity to generate earnings. In 2023, the Group reported a net profit of EUR 2.1 billion compared to a EUR 178.4 million loss in 2022. Profits in 2023 were positively influenced by EUR 345 million tax impact and EUR 471 million provision releases related to legal risks, whilst 2022 results were impacted by EUR 925 million restructuring costs linked to the redundancy scheme in December 2022. Excluding these effects, results were supported by higher revenues, boosted by higher core revenues against a backdrop of higher interest rates as well as lower operating expenses, which largely compensated for a slight increase in loan loss provisions. Morningstar DBRS expects revenues to remain resilient in 2024, as we consider NII has peaked in Q3 2023 and interest rates should reach lower levels this year. Morningstar DBRS also anticipates a moderate growth in operating expenses as the positive impact of the Bank's previous cost savings efforts should mitigate the negative effect of inflation on wages. Morningstar DBRS views that this should provide room for the Bank to absorb a potential deterioration in the cost of risk, which could materialise in the current environment.

Risk Combined Building Block (BB) Assessment: Weak
In recent years, the Bank has made significant progress in reducing its NPEs, following significant disposals but also organic workout. This resulted in a much-reduced NPE stock of EUR 3.5 billion at end-2023 compared to EUR 12 billion at end-2019. The gross NPE ratio stood at 4.4% at end-2023, whilst the net NPE ratio was 2.3%, levels Morningstar DBRS sees in line with the domestic average and closer to the European average. Morningstar DBRS notes that BMPS significantly reduced the total extraordinary litigations and extrajudicial claims relating to civil and criminal litigations concerning financial disclosures in the period 2008-2015 to EUR 1.3 billion at end-2023 (including the Alken case) from EUR 4.1 billion at end-2022.

Funding and Liquidity Combined Building Block (BB) Assessment: Moderate
BMPS's funding position has stabilised in recent years, and Morningstar DBRS expects it to remain stable in the coming quarters. The Bank is largely funded by deposits from retail and corporate clients which totaled EUR 80.6 billion at end-2023, up 9.8% YOY. The Bank has retained a significant exposure to central bank funding at around 11% of total funding much reduced from 16% at end-2022, following TLTRO III exposure maturing. Morningstar DBRS expects ECB funding to remain an important source of funding for BMPS. In 2023, BMPS has resumed issuances on the wholesale markets to meet future MREL requirements, with placements of senior preferred notes for EUR 750 million in Q1 2023, EUR 500 million in Q3 2023 and EUR 500 million in Q1 2024. At end-2023, the Bank maintained a sound liquidity position with an unencumbered counterbalancing capacity of around EUR 30 billion, corresponding to circa 25% of the Bank's total assets. The LCR and NSFR were reported at 163% and 130% respectively at end- 2023, much above regulatory requirements and in line with the Bank's business plan targets.

Capitalisation Combined Building Block (BB) Assessment: Weak
BMPS's capitalisation has strongly improved in 2023 from more challenging levels during the period 2020-2022 when the Bank's capitalisation was impacted by the de-risking process, the transfer of a large portfolio of NPEs to AMCO, the impact from COVID-19 and provisions for litigation risks. The Bank restored its capital levels in November 2022 following a EUR 2.5 billion capital increase with the support of the Italian government, the Bank's main shareholder with a 64% stake, as well as private investors. In 2023, Morningstar DBRS notes the strong improvement in profitability and resulting improved capital generation has led BMPS to report capital ratios at the higher end of the European peer group. BMPS reported a fully loaded Common Equity Tier 1 (CET1) ratio of 18.1% at end-2023 (already taking into account the dividend distribution) compared to 15.6% at end-2022 and a low 11.0% at end-2021. This provides a very large cushion of around 950 bps over the Overall Capital Requirement (OCR) for CET1 ratio of 8.56%. The fully loaded Total capital ratio stood at 21.6% at end- 2023, compared to a minimum OCR for total capital of 13.27%. BMPS reported a fully loaded leverage ratio of 7.0% at end-2023, which Morningstar DBRS views as strong when compared to international peers.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/431150.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental or Social factors that had a significant or relevant effect on the credit analysis.

Governance (G) Factors
Morningstar DBRS continues to view the Business Ethics and the Corporate/Transaction Governance ESG subfactors as relevant to the credit ratings, as Morningstar DBRS considers some of BMPS's legacy issues still carry a certain level of legal risk, although much reduced from past years. Morningstar DBRS still views the Bank has suffered a reputational impact from legacy conduct issues, in particular litigation risk linked to former capital increases. As of end-2023, the total extraordinary litigations and extrajudicial claims amounted to EUR 1.3 billion (including the Alken case), reduced from EUR 4.1 billion in 2022 following a series of positive court rulings in favour of BMPS. In addition, whilst the MEF has partly sold its stake in the Bank, BMPS remains 27% owned by the Italian State. As a result, these risks are incorporated in the Bank's Risk grid grades.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

Notes:
All figures are in EUR unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (22 June 2023) https://www.dbrsmorningstar.com/research/415978/global-methodology-for-rating-banks-and-banking-organisations. In addition DBRS Morningstar uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/427030 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies

The sources of information used for this rating include Morningstar Inc. and Company Documents, BMPS Q4 2023 Presentation, BMPS Q4 2023 Press Release and BMPS 2023 Annual Report. Morningstar DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/431151.

This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Arnaud Journois, Vice President, European Financial Institution Ratings
Rating Committee Chair: Elisabeth Rudman, Managing Director - Global Financial Institution Ratings
Initial Rating Date: January 18, 2013
Last Rating Date: May 17, 2023

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